Market regulators from Australia to Singapore have asked their U.S. counterparts to review proposed rules on derivatives trading, pointing out the potential for conflict with domestic rules and the risks of systemic instability.
Non-U.S. banks that trade with U.S. counterparties are expected to have to comply with new regulations under the Dodd-Frank Act from the beginning of next year.
In a rare unified move, five Asian regulators have sent a joint open letter to the Commodity Futures Trading Commission.
The Australian Securities and Investments Commission, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, the Reserve Bank of Australia and the Securities and Futures Commission in Hong Kong have asked the CFTC to liaise with regulators from other regions before it finalises its guidance on how its derivative rules should be applied overseas.
That would avoid unintended and adverse implications for global markets, the regulators said.
The main areas of concern are the Commodity Futures Trading Commission's definition of counterparties that would have to abide by U.S. rules as well as the tight timeline given to offshore institutions to register with central agencies for mandatory clearing of transactions, the Asian regulators stated.
"The impact from any resulting (likely significant) increase in compliance costs and the potential reduction in liquidity of OTC derivatives markets should not be under-estimated," the note from the Asian regulators says.
The Dodd-Frank Act was spurred by the 2008 financial crisis and aims to impose tighter supervision of cross-border derivatives trade following incidents such as the loss-making trades by the so-called "London Whale" at JPMorgan's UK office.
Non-U.S. banks that trade in interest rate swaps or other over-the-counter derivatives must register as swap dealers with U.S. regulators and abide by their rules on capital requirements and risk management, all of which could dramatically alter the way trades are executed and their costs.
The broad definition of "U.S. person" under the CFTC guidelines, intended by regulators to apply to any person or entity that will have an effect on American commerce, has caused some unease in markets with banks outside the United States reviewing their relationships with U.S. counterparts.
"Market practitioners have...highlighted that it is not easy to identify if a counterparty is a U.S. person," the letter from the Asian regulators states, while requesting the CFTC to defer application of requirements "until there is international consensus on how such cross-border transactions should be regulated".
The regulators highlight possible areas for conflict of interest, such as when local privacy laws could prohibit a non-U.S. swap dealer from reporting data on transactions to U.S. regulators.
Likewise, it would not be practical for non-U.S. entities to register with a clearing agent or a swap execution facility before requirements on margin and capital requirements are finalised, they said.
Asian regulators also highlighted the risk that local and regional clearing agents may not be able to obtain U.S. regulatory approval in time for clearing products mandated by the CFTC, raising the possibility that all such deals are routed through a few global clearing agents and "the potential over-concentration of risks" in these clearing houses.
"Potential market disruption or fragmentation, with consequently increased risks to systemic stability and market liquidity in our markets, may arise as market participants may have to change their business models or even withdraw from certain businesses, all within a relatively short period of time," the letter from the Asian regulators states.
In Hong Kong, Singapore and Japan combined, around $143.1 billion of interest rate derivatives were traded every day in April 2010, according to the most recent figures from the Bank of International Settlements.
While still small compared with the $1.2 trillion traded in the UK and the $642 billion in the United States, the turnover has almost tripled from the $50.8 billion recorded in 2004.
The letter from the regulators also requests the CFTC to bear in mind special local characteristics that could impact the decision to trade derivatives on electronic platforms or centrally clear them.
"For example, in the case of Hong Kong, Australia and Singapore, we are studying whether local market liquidity can justify implementation of mandatory trading of OTC derivatives products on exchanges or electronic trading platforms, and the form of trading venue which will best suit the purpose of improving pre-trade price transparency," they said.
"This will affect our timing for implementing mandatory trading in practice (although the powers for imposing such trading obligation will be in place)."
(Additional reporting by Rachel Armstrong; Editing by Jacqueline Wong)
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